Introduction :-Production is the result of services rendered by various factors of production.

The producer or firm has to make payments for this factor services. From the point of view of the factor inputs it is called factor income while for the firm it is factor payment, or cost of inputs.Generally, the term cost of production refers to the money expenses incurredin the production of a commodity. But money expenses are not the only expensesincurred on the production of a commodity. But there are number of services andi n p u t s such as entrepreneurship, land, capital etc. w h i c h a r e o f f e r e d b y a n entrepreneur without changing any price or receiving any payment for them. While computing the total cost of production, allowance should be made for such expenses.It is therefore essential to have clean understanding for the different types of cost.There are several types of costs that a fi rm may consi der rel evant under various circumstances. Such costs include future costs, accounting costs, opportunitycosts, implicit costs, fixed costs, variable costs, semi variable costs, private costs, social costs, common costs, etc. For the purposes of decision-making, it is essential toknow t he f undamental diff erence bet ween the mai n cost concepts al ong with the conditions of their use in decision-making. 1. Actual (or, Acquisition or, Outlay) Costs and Opportunity (or, Alternative)Costs. Actual costs are the costs which the firm incurs while producing or acquiring a good or a service like the cost on raw material, labor, rent, interest, etc. The books of account generally record this information. The actual costs are also called the outlay costs or acquisition costs or absolute costs. On

the other hand; opportunity costs or alternative costs are the return_ from the second-best use of the firm s resources whichthe firm forgoes in order to avail of - the return from the best use of the resources. Suppose that a businessman can buy eit her a lat he machine or a paper pressi ng machine with his limited resources and he can earn annually Rs.50,000 and Rs.70,000respectively from the two alternatives. A rational businessman will certainly buy a paper-pressing machine which gives him a higher return. But in the process of earningRs.70,000, he has forgone the opportunity to earn Rs.50,000 annually from the lathemachine. Thus, Rs.50,000 is his opportunity cost or alternative cost. The difference between actual cost and opportunity cost is called economic rent or economic profit. For example, economic profit from paper-pressing machine in the above case is Rs.70,000-Rs. 50,000 = Rs.20,000. As long as economic profit is above zero, it is rationalto invest resources in paperpressing machine. 2. Sunk Costs and Outlay Costs. As discussed above, outlay costs mean the actual expenditure incurred for producing or acquiring a good or service. These actual expenditures are recorded inthe books of account of the business unit, e.g., wage bill. These costs are also knownas actual costs or absolute costs.

Types of costs 2 Sunk costs are the costs that are not altered by a change in quantity and cannot be recovered; e.g., depreciation. Sunk costs are a part of the outlay costs. However,most business decisions require cost estimates that are essentially incremental and notsunk in nature. 3. Explicit (or, Paid-out) Costs and Implicit (or, Imputed) Costs: Explicit costs are those expenses which are actually paid by the firm (paid-out costs). These costs appear in the accounting records of the firm. On the other hand, implicit or imputed costs are theoretical costs in the sense that they go unrecognized b y t h e a c c o u n t i n g s ys t e m. Th e s e c o s t s m a y b e d e f i n e d a s t h e e a r n i n g s o f t h o s e employed resources which belong to -the owner himself: For example, the interest payment on borrowed funds is an explicit cost and enters the accounting record,-butthe amount of interest which the employer could have earned (and which he forgoes when he uses his own capital in his firm) is his implicit cost. Similarly, the amount of rent, wages, utility expenses, etc. which are paid out are the explicit costs of the firm,wh i l e wa g e s , r e n t , e t c . wh i c h a r e d u e t o t h e e n t r e p r e n e u r f o r e mp l o yi n g h i s o wn r e s o u r c e s i n t h e f i r m a r e a l l i m p l i c i t c o s t s . T h e e xp l i c i t c o s t s a r e i mp o r t a n t f o r calculation of profit and loss account, but for economic decision-making the firmtakes into account both the explicit as well as the implicit costs. 4. Opportunity Costs and Imputed Costs: Opportunity cost is concerned with the cost of forgone opportunities. In other words, it is the comparison between the policy that was chosen and the policy thatwas rejected. The concept of opportunity cost focuses attention on the net revenue that could be generated in the next best use of a scarce input. Since this net

revenue must be given up, or sacrificed, to make the scarce input available for the best use, it iscalled opportunity cost of the input. For Example, if the firm owns land there is noc o s t o f u s i n g t h e land (i.e., the rent) in the firm's account. But the firm h a s a n opportunity cost of using this land, which is equivalent to the rent forgone by notletting the land out on rent. Imputed costs, on the other, are a sub-division of opportunity costs. Thesenever show up in the accounting records but are definitely important for certain typesof decisions. Besides the return forgone on the use of , self owned resources, theimputed costs also include rent (never paid or received) on idle land, depreciation onfully depreciated property still in use, interest on equity capital, etc. For example, imputed cost concept can be usefully employed by a firm that wishes to evaluate therelative profitability of its two warehouses in order to decide whether to continue,d i s c o n t i n u e o r l e a s e t h e m . H o w e v e r , t h e c o n c e p t o f o p p o r t u n i t y c o s t i s m o r e comprehensive as it relates to all the resources (both borrowed and owned) whereas the concept of imputed cost applies only to the self-use of the self-owned resource. 5. Incremental (or, Avoidable or, Escapable or, Differential) Costs andSunk (or, Non-avoidable or, Non-escapable) Costs: The incremental costs are the additions to costs resulting from a change in thenature and level of business activity, e.g., change in product line or output level,

Types of costs 3adding or replacing a machine, changing distribution channels, etc. Since these costscan be avoided by not bringing about any change in the activity, the incremental costsare also called avoidable costs or escapable costs.

Moreover, since incremental costsmay also be regarded as the difference in total costs resulting from a contemplatedchange, they are also called differential costs. On the other hand, sunk costs are those that do not change by varying thenature or the level of business activity. For example; all the past costs are consideredsunk costs because any change in the activity and the resulting incremental costs willhave to take these preceding costs as given: One of the most important sunk costs isthe amortization of past expenses, e.g.; depreciation. Sunk costs are irrelevant for decision-making as they do not vary with the changes contemplated for future by themanagement. It is the incremental costs which are important for decision-making. Although variable costs are generally incremental, but all incremental costsare not variable costs. Incremental costs may include fixed costs also, e.g.; a new proposal may involve some expenditure of a fixed nature also, besides the variableone. Further, whether a particular cost belongs to the category of sunk or incrementalcost; depends upon the conditions of each business activity. A particular cost may besunk cost in one case and incremental cost in the other case. 6. Book Costs and Out-of-pocket Costs. Out-of-pocket costs are those expenses which are current cash payments tooutsiders. All the explicit costs like payment of rent, wages, s a l a r i e s , i n t e r e s t , transport charges, etc., fall in the category of outof-pocket costs. On the other hand, book costs are those business costs which do not involve any cash payments but for them a provision is made in the books of account to include them in profit and lossaccounts and take tax advantages, like the provisions for depreciation and for unpaidamount of the interest on the owner's capital employed in the firm. In a way book costs are the imputed costs or the payments by a firm to itself 7. Accounting Costs and Economic Costs: Accounting costs are the actual or outlay costs. These costs point out howmuch expenditure has already been incurred on a particular process or on productionas such.

Since these costs relate to the past, these are generally s u n k c o s t s . Th e accounting costs are useful for managing taxation needs as well as to calculate profitor loss of the firm. On the other hand, economic costs relate to future. They are in thenature of the incremental costs-both the imputed and the explicit costs as well as theopportunity costs. Since the only casts that matter for business decisions are the futurecasts, it is the economic costs that are used for decision-making. 8. Private Costs and Social Costs: Economic costs can be calculated at two levels: micro-level and macrolevel.The micro-level economic costs relate to functioning of a firm' as a production unit,while the macro-level economic costs are the ones that are generated by the decisionsof the firm but are paid by the society and not the firm. Far example, if the decision of a firm to expand its output leads to increase in its costs, this cost will be of the former